European financial markets experienced significant turbulence this week as investors reacted to Germany's proposed fiscal reforms and the European Union's ReArm Europe plan. On Wednesday, yields on German government bonds soared, with the yield on the 10-year bund climbing approximately 30 basis points. By 12:28 p.m. London time, the yield on these bonds had risen an additional 7 basis points. Concurrently, Germany's DAX index hit a record high, reflecting heightened market activity.
Germany's new political footing has disrupted existing economic forecasts, notably challenging Bank of America's outlook. The shift in fiscal policy has fueled a greater appetite for riskier assets across Europe. Analysts at RaboBank noted a 14 basis point increase in 10-year euro zone inflation swaps, attributing this to the political developments in Germany. The fiscal news and supply considerations have dominated this week's market movements.
The bond sell-off extended beyond Europe, impacting Japanese markets as well. Yields on Japanese government bonds increased by 7 basis points during Thursday's trading hours, reaching near 16-year highs. This rise indicates broader market tension, despite capped rates.
"Watch Japan's rising yields despite capped rates — they could signal broader market tension." – Naeem Aslam, chief investment officer at London's Zaye Capital Markets
Market analysts suggest that the yield on Germany's 10-year bund could reach 2.75% in response to the proposed fiscal reforms.
"We believe 10y bund yields could reach 2.75% in response." – Marc Ostwald, chief economist and global strategist at ADM Investor Services
Germany's political and fiscal changes are not only affecting European markets but also reverberating globally. The yield on the benchmark 10-year Treasury in the U.S. was last seen trading 4 basis points higher at around 4.311%. These developments come ahead of the European Central Bank's latest monetary policy update, which is expected to further influence market dynamics.
Germany's fiscal stance represents a significant shift in policy, with potential long-term impacts on European and global markets.
"Germany is delivering a paradigm shift in its fiscal stance." – Marc Ostwald, chief economist and global strategist at ADM Investor Services
The proposed plans suggest a substantial increase in issuance patterns due to the urgent need to boost defense spending in Europe.
"These plans suggest a significant increase in issuance patterns due to the urgent need to boost defence spending in Europe." – Emmanouil Karimalis, rates strategist at UBS Investment Bank
This week's market movements indicate that investors are pricing in a major policy regime change, driving substantial risk-on behavior for European assets.
"There's no doubt that markets are pricing in a once-in-a-generation policy regime shift, which has brought about a huge risk-on move for European assets." – Emmanouil Karimalis, rates strategist at UBS Investment Bank
Meanwhile, Ralf Preusser from Bank of America Global Research highlighted the broader implications for global markets. He pointed out that inflation risks and geopolitical factors remain significant challenges.
"The Fed may struggle to deliver quick cuts given inflation risks, Europe is no longer funding the U.S. fiscal expansion, but its own, and tariffs and geopolitics are still more damaging for the rest of the world than the U.S." – Ralf Preusser, global head of G10 rates and FX strategy at Bank of America Global Research